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Monday, June 17, 2013

Moving Your Business out of California


As California continues to be one of the more expensive states to conduct business in, many owners may be considering moving their business to another, less expensive state.

Before packing your bags and crossing the state line, there are a few things to consider on the tax side.

First, California will continue to require your entity to file California income tax returns and pay at least an $800 minimum tax if your entity is considered to be “doing business” in the state. Doing business is defined as actively engaging in any transaction in California for the purpose of financial or pecuniary gain or profit.

This definition is broad. However, under California’s economic nexus rules, an entity is also considered to be “doing business” in the state if any of the following apply:

  • An entity has sales (including sales by an agent or independent contractor) in California that exceed the lesser of $509,500 or 25% of the entity’s total sales.
  • An entity has real property and tangible personal property in California that exceeds the lesser of $50,950 or 25% of the entity’s total real property and tangible personal property.
  • An entity has California payroll that exceeds the lesser of $50,950 or 25% of the total compensation paid by the entity.

The following example illustrates the economic nexus rules. Corporation A, an out of-state seller of tangible goods, has no property or payroll in California. During tax year 2012, Corporation A has $1,000,000 of sales in California. Corporation A will have a California filing requirement for tax year 2012 and will be subject to the $800 minimum tax.

Essentially even if an entity does move out of state, if it has a physical presence (i.e., employees, office space, etc.) or is tapping into the California market, there is a good possibility it will still be caught up in California’s tax web.

Secondly, owners of a flow-through entity (i.e., a limited liability company “LLC”) who reside in California will be subject to California income tax on the flow-through entity’s income regardless of where the business is organized. California taxes its residents on their worldwide income without consideration as to the income’s source.

Unfortunately, relocating a California LLC to Nevada with members who continue to reside in California, will not help with the tax bill. Furthermore, a flow-through entity is considered to be doing business in California if it has general partners or managing members in-state.

If it really is time to relocate to another state, there are several options on how to get there depending on whether the business is organized as a corporation or as a flow-through entity.

A business organized as a corporation has three available options:

  • Continue as a corporation in the old state and register as a foreign corporation doing business in the new state;
  • Dissolve the corporation in the old state and form a corporation in the new state; or
  • Do a reorganization, where a corporation is formed in the new state and the old corporation is merged into it.

The following factors should be considered before choosing one of the available options.

California minimum tax: If you maintain the old corporation in California or are considered to be “doing business” in the state, as discussed above, the corporation must continue to file California income tax returns and pay the $800 minimum tax.

Federal tax issues: Liquidating a corporation may result in a tax train wreck to both the business and its shareholders. For example, when a C corporation with appreciated assets liquidates, it must recognize gain inside the corporation equal to those assets’ fair market values less their carrying costs. Shareholders who receive the company’s assets upon liquidation must also recognize a taxable gain if the carrying value of their shares is less than the fair market value of the assets received in liquidation.

Reorganization: For a C corporation, a reorganization can be accomplished entirely tax-free. There is no tax on the merger of the old corporation into the new one. It’s as if there had been no change for federal tax purposes, but the merged corporation does cease to exist in its original state.

Dissolution costs: If you dissolve your business and either form a new one or merge it into a new corporation, you must go through the formalities of dissolving the old one. Generally, this process requires filing dissolution paperwork with the California Secretary of State and ensuring all outstanding tax filings and tax liabilities are current.

A business organized as an LLC has similar choices to that of a corporation:

  • Continue the LLC in California and register to do business as a foreign LLC in a new state. Like corporations, if the LLC remains in state or is considered to be “doing business” in state it will be required to file a California income tax return and pay the $800 minimum tax.
  • Liquidate the LLC in California and form an LLC in a new state. Unlike corporations, liquidating an LLC generally does not result in any negative federal tax consequences to either the LLC or the members.
  • Form an LLC in a new state and merge the existing LLC into it. This is viewed as a continuation of the old LLC so there are no immediate tax consequences, provided LLC members from the old state continue to own at least a 50% interest in the capital and profits of the LLC in the new state

Overall, moving your business out of California is easier said than done and requires careful consideration to ensure you end up at your ultimate destination point.

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